How to End Wage Stagnation

By John E. Schwarz, Harry M. Lasker, David Callahan, & William C. Coleman

Tagged Economicswages

Nearly three years after Donald Trump won the presidency, in part by promising a substantial boost for American workers, Democrats are still attempting to agree on an economic message to help them win back power. So far, the progressive wing of the party has been more forceful on this front, arguing that the nation must attack today’s record levels of inequality by dramatically raising taxes on the rich, reining in corporate power, and offering ambitious new government benefits, like greatly expanded health care and free college.

Parts of this approach make sense and align well with public opinion; polls show robust support for a more progressive tax system and stronger oversight of corporations. Overall, though, emphasizing bold promises to lift up working families mostly through statist redistribution carries risks for Democrats in two key respects. First, many Americans question government’s ability to solve big problems, while a sizeable slice of voters—including non-college whites in key swing states—actively oppose programs that seem to offer “something for nothing.”

But a second and bigger shortcoming of this strategy is that it doesn’t promise American workers what they need and want most: higher paying jobs. Trump tapped into that deep thirst by pledging to limit free trade, restrict immigration, and roll back regulations in order to expand high-paying employment in manufacturing, energy, and other sectors. While these promises haven’t panned out, they resonated strongly with many voters—such as those in industrial Midwestern states that delivered victory to Trump.

Democrats, meanwhile, for all their talk of economic issues, have yet to hammer home their own grand vision on a key point: how to generate better pay for all those working Americans who feel stuck and left behind. Indeed, they’ve given remarkably little attention to the core problem facing U.S. workers, which is prolonged wage stagnation and the highly skewed way that U.S. businesses divvy up earnings. Instead of focusing laser-like on this overarching cause of inequality, progressive Democrats are mainly offering a list of programs to deal with the downstream symptoms of chronic low wage growth that leave the underlying problem itself unresolved.

Democrats have yet to hammer home their own vision of how to generate better pay for middle-class Americans.

Today, with the election less than a year away, Democrats need to combine their emphasis on redistribution with far greater attention to pre-distribution strategies that can induce American businesses to share the fruits of prosperity more broadly with their workers. Besides illuminating the abject failure of the Trump economy for most workers, this approach would be able to sidestep familiar sand traps about the size and cost of “big government,” and put the spotlight where it really belongs: on how business treats its workers—and how it can be made to do better.

Here, we explore the challenge that wage stagnation poses and offer a plan to dramatically boost the fortunes of U.S. workers by reshaping certain features of the corporate tax system in a way that leads businesses to make very different choices in how they distribute their earnings.

Wage Stagnation and Its Effects

It’s hard to overstate the magnitude of America’s pay gap. Over the past 45 years, as GDP and productivity per worker have both doubled, median real wages for all production and nonsupervisory workers—representing 75 percent of the American labor force—increased barely at all, by a mere 12 percent. By contrast, in those same 45 years, pay to employees at the top of the income ladder escalated by 130 percent, and companies boosted their profits by a staggering 200 percent.

Today’s lopsided compensation practices partly stem from structural changes in the economy, including automation and globalization. Even so, businesses retain much leeway in how to allocate their winnings. Businesses in exactly the same industry often allocate quite different shares of their earnings to labor. Yet despite that, the norm for decades now has been for businesses to choose to direct a disproportionate share of gains in earnings to management as well as increased profits going to owners and shareholders. Workers have been receiving a sharply shrinking share of a growing pie over the past half century.

This fundamental shift in how the economy works has had myriad negative effects on U.S. society.

At the macroeconomic level, there’s now a substantial body of evidence that the failure of businesses to more broadly share their earnings with middle- and working-class employees operates as a substantial drag on growth. The reason here is hardly a mystery, and points to a truth that Henry Ford understood a century ago: A strong economy depends on ordinary people having enough income to buy consumer goods, services, and homes.

It should be equally obvious why chronic wage stagnation affecting so many working Americans would be damaging to the fiscal health of federal, state, and local government. People just scraping by not only pay less in taxes but make much greater use of public assistance. Studies show that large numbers of workers at low-wage companies like Walmart and McDonald’s rely on SNAP, Medicaid, and other assistance programs. Many low-wage workers also make use of the Earned Income Tax Credit and the Child Tax Credit. Through these and other programs, government is effectively providing many billions of dollars in subsidies to low-wage employers.

Finally, the negative political effects of wage stagnation have become starkly clear in recent years, especially with the populist explosion in 2016 and thereafter. Many Americans believe, and rightly so, that the wealthy, the professional class, and corporations have been the main beneficiaries of recent economic growth while ordinary people have been left behind. People are angry and they’re also scared, given the precarious predicament of so many households. Surveys show that 40 percent of Americans would cover a $400 emergency either by borrowing or selling an assets—to cite just one indicator of how squeezed many people are today.

As a presidential candidate, Trump was skilled at tapping into that anger. His calls for economic protection and renewal resonated with many voters, not just in Midwestern states hit hard by deindustrialization but also elsewhere and helped secure his victory through the Electoral College.

In turn, Trump’s erratic and damaging tenure in office has underscored the dangers that populism can pose to political and even economic stability. One clear takeaway from his rise is that when ordinary Americans are largely excluded from the nation’s prosperity over prolonged periods, bad things are likely to happen—a lesson that has deep roots in history. As the investor Nick Hanauer wrote in a widely read 2014 essay in Politico: “No society can sustain this kind of rising inequality. In fact, there is no example in human history where wealth accumulated like this and the pitchforks didn’t eventually come out.”

So, how have President Trump’s policies fared in attacking stagnant wages and stalled economic mobility? Despite headline job creation, low unemployment, and rising nominal wage increases (unadjusted for inflation), sluggish compensation growth has continued apace for everyday working Americans. According to gold-standard data from the Bureau of Labor Statistics, increases in real hourly earnings (after inflation) for rank-and-file working Americans, also known as production and nonsupervisory workers, have slowed under Trump to an annual rate of 0.9 percent as compared to 1.3 percent per year during Obama’s final term. America’s production and nonsupervisory workers make up nearly three-quarters of the labor force, or approximately 110 million workers. Trump’s policies have not only failed to jump start those workers’ wages, but have instead accomplished the reverse. It would be worse still had the minimum wage not been raised by many states and localities around the nation. As for 7 million new jobs added since Trump entered office, job creation remains about the same as during the prior Obama economy, but nearly half of those newly created jobs have been low-paying ones. Even were wages to grow strongly for a bit, it wouldn’t put a dent in the effects of wage stagnation over the past 45 years. A huge opportunity exists here for Democrats—if they have a credible solution.

An Inadequate Democratic Playbook

In recent years, decades of rising economic inequality have finally become a major focus of public debate. Even some corporate and finance leaders are increasingly worried about how U.S. capitalism, in its present form, is leaving behind too many workers and families to be politically and economically sustainable. In August, a who’s who of top CEOs signed on to a statement by the Business Roundtable that, among other things, called for fairer compensation of employees.

Meanwhile, top Democrats are talking about economic inequality with a forcefulness not seen since the 1930s. Some, like Elizabeth Warren and Bernie Sanders, have proposed bold, multi-trillion dollar plans to address many of the urgent problems of low- and middle-income Americans—like the lack of affordable options for health care, housing, child care, and higher education.

Despite this sea change in policy discourse, though, leading Democrats have paid remarkably little attention to directly attacking and reversing wage stagnation—even though it’s the core underlying driver of the economic hardship experienced by tens of millions of U.S. households.

Elizabeth Warren’s campaign messaging and policy positions is a case in point. Her boldest and most visible pronouncements  focused on achieving Medicare for All, reining in corporations, and raising taxes on the super-rich. Of the 25 or so policy plans presented by Elizabeth Warren’s campaign under the rubric “Rebuild the Middle Class,” for example, only several focused directly on workers and wages. Her plans that dealt most explicitly with this topic proposes strengthening/expanding unions and labor protections, placing workers on corporate boards, ensuring collective bargaining, and raising the minimum wage to $15 an hour. Senator Sanders and other Democratic candidates have made similar proposals.

Raising the minimum wage is an important proposal, yet it would fall far short of achieving a transformational rise in living standards. Even a hike to $15 an hour would boost wages appreciably for only a quarter of U.S. workers who are suffering the effects of wage stagnation.

Reforms that enable more workers to join unions and revitalize collective bargaining have been another core plank of the Democratic Party for decades. If ever implemented, they would surely result in wage gains. However, such gains could take many years to be fully realized given that fewer than 7 percent of private sector employees now belong to a union. And, while essential for many reasons, strengthening worker power in the economy has had a record of mixed success in other advanced economies as a means of lifting pay sufficiently to defeat wage stagnation.

Likewise, proposals to boost the EITC—also popular among many progressives—would only do so much for U.S. workers. Last year, the EITC put $63 billion into the pockets of workers—a relative pittance compared to the many hundreds of billions of dollars in additional wages that workers would be receiving if business earnings were shared the way they were in previous periods of U.S. history. Importantly, too, the EITC doesn’t actually produce any wage increases from employers but instead provides an income subsidy from government for low-paid workers. It also leaves open the possibility that companies will free-ride by substituting all or part of an expanded EITC subsidy for wage increases they would otherwise have given.

Aggressive positioning by progressive Democrats on inequality is a welcome development—even ideas that court obvious risks at the ballot box. What’s still missing from this emerging playbook, though, are bold new ideas for changing how businesses operate enough to end a half century of stalled wages and actually deliver major pay raises to most workers—both now and over the long-term.

Democrats were the majority party through much of the twentieth century in large part because they were able to ensure steadily rising pay and upward mobility for the majority of Americans—a promise that transcended divisions of race, class, age, geography, and gender; appealing to nearly everyone with a job. It’s no coincidence that the onset of inflation and wage stagnation in the 1970s, and the lack of a stronger Democratic response to these problems, coincided with the party’s declining fortunes. Until Democrats have a realistic plan to ensure growing pay and mobility for workers again, they’re likely to continue to struggle politically. It seems almost suicidal for Democrats to go into the 2020 confrontation with Trump without a much stronger proposal for how they’ll help non-college white voters who are skeptical of government but hunger to move upward through work. And, it’s not just these voters who are crucial to deciding the election and likely to be animated by a stronger message on wages. It’s the more than 100 million nonsupervisory workers who’ve been hurt by wage stagnation—voters who come from every demographic group and live in every part of the nation.

If Democrats have no narrative or real solution to stalled wages, many Americans will continue to buy into Trump’s and the Republicans’ message about how to lift workers. That story promises that with lower taxes, less regulation, more capital investment, and—Trump’s addendum—a tougher approach to trade and stricter controls on immigration, the economy will boom and anyone who works hard will see their wages rise. Yet today, with near historic tight labor markets and the economy coming off strong GDP growth, we see dramatic real-time evidence that these Republican solutions don’t work to defeat wage stagnation and boost workers’ pay. That gives Democrats and progressives an open invitation to push their own fresh story for how to raise wages, one that should focus on changing corporate behavior.

Thinking More Boldly

The key to ensuring steady wage growth for all workers is to steer business to change how earnings are divvied up among key stakeholders. While it’s not realistic to expect corporations to upend current compensation patterns overnight, one big step companies could take is to start sharing gains in earnings proportionately with workers going forward. As businesses grow, they could commit to keeping pay for rank-and-file employees as a stable share of total compensation plus profits. For example, if the percentage of total compensation and profits currently going to a company’s rank and file workers is 50 percent, the company would commit to keeping the amount at about that same level as time goes forward.

This simple step, to have wages keep up with growth, may not sound very radical, but its effects would be dramatic over time, even if real GDP growth remains at around 2 percent annually. Our analysis finds that if businesses kept today’s share of total compensation and profits going to rank-and-file workers stable, it would transform the wage picture—while also safeguarding solid profits. Such an approach would lift the average real compensation of the bottom 90 percent of workers at an annual rate four times faster than over the past 15 years (34.6 percent in 15 years versus about 8.7 percent), boosting gains in real compensation to a level approaching the iconic 1950s and ‘60s.

Judging by the Business Roundtable’s statement last August, some companies may be ready to embrace this practice voluntarily—understanding what’s at stake for the nation. Far-sighted management wants and needs a predictable business environment with lower risk. A future in which workers remain stuck and unable to get ahead creates conditions that slow growth due to constrained demand, potentially destabilizes the economy from excessive consumer borrowing, and leads to feelings of marginalization and anger that produce rising political turmoil and unpredictable policies. A growing number of corporate leaders understand these realities, as the Business Roundtable statement indicates. They can and should be invited to partner in long-overdue changes in compensation practices to ensure more broadly shared prosperity.

And what about those who aren’t willing to act voluntarily? They will need enticements to change entrenched practices.

A New Metric and New Incentives

The corporate tax system offers an effective means to achieve this key goal: in particular, tying net corporate taxes to whether companies share earnings equitably with their workers. That’s the foundation of a plan we are developing called “Raise America’s Pay,” or RAMP. The plan offers modest tax incentives to businesses that commit to paying a stable proportion of earnings to the bottom 90 percent of workers as earnings grow. More important, businesses that don’t choose to share gains and increase wages proportionately would lose many of the savings they’re receiving under the 2017 tax law as well as eligibility for a range of tax breaks available for corporations. The loss of tax privileges is substantial. While the 2017 tax law was supposed to spur economic growth in a way that benefited everyone, that has yet to happen. RAMP would ensure that it does.

What follows is not written in stone but rather an illustrative example of a proposal whose effects we have modeled. The exact specifics of any proposal would come only after different sides have weighed in.

At the center of our approach is a new metric for wage fairness: the Compensation Ratio, or CR. Using current data that are already available, it’s possible to measure the proportion of a company’s total compensation and profits that goes to paying everyday workers—the bottom 90 percent of employees, generally those earning beneath $100,000 annually. This portion is the company’s CR. In turn, by monitoring the CR, it’s possible to determine how any business is distributing the fruits of annual growth in earnings. With it, we can see clearly within individual industrial sectors which companies are shrinking the share going to everyday workers. This transparency holds the key to bold policy since declining CRs reflect the root cause of wage stagnation. Across the American economy, the average CR has declined steadily since wage stagnation began around 1973, from 61 percent to 46 percent.

At the core of RAMP is the simple proposition that companies should hold their CRs stable over time. When this happens, as growth occurs and more resources become available for compensation and profits, pay for the bottom 90 percent of workers will automatically rise in similar proportion with pay for the top 10 percent of workers and profits. Pay will have become rewired to growth.

To reduce likely political opposition as well as advance a vision of a new partnership for shared prosperity between business, workers, and government, RAMP would be a voluntary program. But, tying net taxes to whether a company keeps its CR stable will give companies powerful incentives to join because of the combination of the tax benefits they would enjoy and the steep tax penalties they would avoid. On the benefits side in the proposal we have modeled, most firms that agree to hold their CR stable would pay lower corporate taxes—keeping 20 percent of monies due to the IRS as long as a company uses these tax savings to cover the cost of pay raises for its rank-and-file workers.

For reasons of equity, however, not all companies would get these benefits. Companies with the lowest CRs within their sectors—the lowest proportions of compensation going to the bottom 90 percent of workers—would have to finance the raises entirely themselves and would not be eligible for tax benefits.

The tax benefits constitute the carrots offered by RAMP, but they are accompanied by a stick: the tax penalties, which apply only to those companies that remain outside of RAMP. In the proposal we modeled, companies that don’t commit to keeping their CR stable and share gains with their workers would lose three-fifths of the savings they got under the 2017 tax bill and also three-fifths of the tax loopholes those companies have been using. In addition, they would also lose priority for federal contracts, totaling $560 billion in 2018.

Behind these penalties is a compelling logic. Current tax law, as well as longstanding tax breaks, are aimed at spurring business behavior that generates growth and prosperity to the benefit of all. Companies that are sharing gains with their workers deserve all the benefits of the current tax system. Companies that instead don’t share their gains with workers, and leave workers out, shouldn’t be receiving the same beneficial treatment under tax law.

Economists are often skeptical that tax incentives can achieve major changes in corporate behavior. That’s understandable, given the long history of changes in tax law that have produced only business as usual by companies. However, our analysis shows that the combination of carrots and sticks under RAMP would indeed have powerful effects on business compensation practices. They would fundamentally change the calculus around raising wages.

We have extensively modeled the likely effects of RAMP looking at a great range of companies across multiple sectors. And what we’ve found, in nearly all cases, is that the net loss of tax benefits an employer would sustain would far exceed the cost of worker raises. The powerful effects of the sticks in RAMP, along with the carrots, would ensure that an employer’s after-tax profits will always be significantly higher if they’re in the RAMP program, raising workers’ wages, rather than outside of it and not doing so. Companies participating in RAMP will gain an advantage of one-fifth greater after-tax profits on average even after paying higher wages than if the companies decided not to participate in RAMP (incentives can also be made greater if they need be). While participation in RAMP is voluntary, most companies would see an overwhelming imperative to join.

Currently, many companies fear that if they embrace high-road wage practices they’ll put themselves at a competitive disadvantage and face the ire of investors. They worry that good guys finish last. RAMP flips that poisonous dynamic; companies giving pay raises that track with growth will do appreciably better than those that do not. Under RAMP, there will always be a significant “shareholder value gap” between the two, favoring the company that shares gains, so in effect transforming “shareholder value” into “stakeholder value” as regards owners and workers. Once again, the great engine of American business will work as it should: pulling everyone along to a more prosperous future.

Compliance and Gaming

To ensure a level playing field for participants, it is critical to institutionalize an effective means to manage compliance and to control gaming—one that is automated, tested for its effectiveness, and will minimize the complexity of the regulatory process.

The Compensation Ratio of individual companies would be based on a running average of operations during the previous five years and would be permitted to vary within narrow parameters. When achieving efficiencies, companies can further lower their CR with the stipulation that a solid portion of the savings from those efficiencies go to benefit workers (including those laid off). Today nearly all gains from such savings go to the top and to profits. These steps will bring greater equity to the wage effects of practices like outsourcing and automation. In addition, sharing gains will act to restrain such practices unless returns are above average. Keeping CRs stable will also induce current monopsonist companies to share gains and raise wages.

In terms of compliance, all businesses would be eligible to join RAMP, but the tax penalty side would apply only to companies with more than a certain number of workers (our work suggests businesses that are beyond the start-up phase with 20 or more workers). Even though there are hundreds of thousands of such businesses spanning a broad array of different industries, ensuring compliance with RAMP would be relatively straightforward and not require the creation of a massive new bureaucracy within the federal government. The reason for this is that administration of the program would occur largely through the normal tax process, and there would be little need for extensive new paperwork. The CR of companies can be monitored mostly from data that firms already report publicly through their W2 forms and audited financial statements.

Of course, it goes without saying that companies may attempt to game the plan. It’s therefore critical that the RAMP program include mechanisms for detecting attempts to get around the rules. Given the vast number of companies that will participate in RAMP, it’s also vital that any surveillance system to deter gaming be automated so it can operate at scale to produce clear, reliable red flags when companies are not in compliance. To minimize the complexity of the regulatory process, such red flags must be grounded in data that inform a transparent certification process.

To this end, the program we’ve designed includes an application capable of detecting gaming based upon annual reporting of four simple audited metrics available to any employer, metrics that can also be checked against other data that companies report. We’ve extensively modeled and tested this anti-gaming system in a variety of scenarios involving outsourcing and other likely gaming techniques. We’re confident that by monitoring a combination of CR shifts and gaming flags, it will be possible to determine with little error which participating companies are in good standing and which are not.

A Return to Shared Wage Growth

Given the large financial impact of the tax incentives, most companies will join RAMP. In tandem with a higher minimum wage, we estimate that at full implementation RAMP and its ripple effects will raise pay substantially for more than 100 million U.S. workers across every part of the economy, ending a half century of wage stagnation. Critically, it would do so without recurring political battles to secure government funding—fights that will become all the more bitter as fiscal pressures grow amid the aging of the baby boomers.

More specifically, our analysis projects that average real compensation for workers in RAMP will increase by more than $11,500 in today’s dollars over ten years (raising the average by about 26 percent in those ten years, and approximately 35 percent over 15 years), a rate of growth about four times greater than the growth workers have experienced over the past 15 years. Stalled economic advancement, at long last, would be in the rear-view mirror.

Lifting pay substantially should also reduce federal spending on assistance programs, ranging from food stamps to the ACA and Medicaid. With wages increased many times the size of the tax redirection because of the tax penalties, plus with reduced federal assistance and added jobs because of significantly boosted consumer demand from better paid workers, the combination will help improve the fiscal position of the federal government in an era of growing budgetary pressures.

Restoring the American Dream of upward mobility is likely to have profoundly positive effects as well on the fabric of U.S. society and the nation’s political culture. Democracy is only as strong as its ability to help citizens move ahead in their lives. When that becomes a serious problem for too many, it is a problem for all. Workers with steadily rising rather than stagnant wages are likely to have a much stronger faith that the “system” is working fairly. These feelings should help dampen polarization, reduce the appeal of an angry populism, and help restore Americans’ trust in public and private institutions alike.

In turn, a Democratic Party that can again help citizens move ahead in their lives through good jobs that pay middle-class wages will be well-positioned to win elections for years to come. Progressive candidates have done an enormous service in this presidential season by moving inequality to the forefront of the party’s agenda. Now it’s time to build on this energy to focus squarely on what working Americans of all political stripes want more than anything else: bigger paychecks.

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John E. Schwarz, Harry M. Lasker, David Callahan, & William C. Coleman are co-directors of The Project to Raise America’s Pay.

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